Western Digital Corp (NASDAQ: WDC) faces NAND margin risk and secular pressure in HDDs, Goldman Sachs’ Mark Delaney said in a report. He downgraded the rating on the company to Sell from Neutral, while reducing the price target to $38 from $47.

Reasons For Downgrade

Analyst Mark Delaney mentioned that there is 16 percent downside for Western Digital, versus 2 percent “average upside for our coverage.” He mentioned that the NAND margin risk arises from the following factors:

Oversupply: NAND capex is expected to rise to 45-50 percent in 2016, creating oversupply in 2017.

3D Yield Risk: Western Digital lags Samsung in 3D NAND and is making attempts to ramp quickly, which creates yield risk.

Royalty: The royalty agreement with Samsung ends on August 14 this year, and currently represents 8-9 percent of Western Digital’s EBIT. The company would need to renegotiate the agreement, and would possibly receive a lower rate.

Estimates Below Consensus

The EPS estimates for FY17, FY18 and FY19E have been reduced from $3.15 to $3.00, from $5.27 to $4.55 and from $5.50 to $5.00, respectively, to reflect lower sales and margins. The EPS estimates for FY17 and FY18 are 25-30 percent below the Street.

“To the extent the stock trades higher on short-term events, we would use it as an opportunity to Sell the stock given risks that we believe could pressure WD’s business in the next few years,” the analyst commented.

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